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The Fed’s September FOMC meets this week and a rate decision will be made on 9/21. Last week, equities suffered the largest weekly loss in 2H2022 so far, falling 4.8% (4th worst week of 2022) on the heels of the August CPI.

consensus is looking for +75bp
futures markets pricing in roughly 1 in 4 chance of 100bp
as Goldman Sachs economists note, there are a few reasons the Fed could lean more hawkish vs prior

The summary of their FOMC preview is below and the rationale for +75bp (slightly higher vs post-July FOMC):

equities are up (although higher equities are not underlying drivers of recent inflation pickup)
labor markets strong enough to handle “aggressive tightening”
Fed losing patience and want faster progress
possibly re-evaluating “neutral rate”

A lot of bad news has been priced in the last 4 weeks. Take a look at the weekly S&P 500 chart below:

the downturn in equities in the past 4 weeks stem from Powell’s speech at Jackson Hole and the August CPI (last week)
prior to these events, equities were making far steadier progress in 2H2022

Markets not likely to be “negatively” shocked by +75bp, but risk is if Fed decides terminal rate higher than 4.5%

The current consensus forecasts for Fed Funds is shown below and as we highlight:

+75bp in September
+50-75bp in November
+25bp in December

So, from a market view, a few things stand out:

Last big hike is September or November
Modest hikes going forward and 4.5%-ish terminal rate
The worst of the hikes is this Sept meeting or November
If this or November are the worst of the hikes,
shouldn’t markets start to see “the beginning of the end”?

I guess this is more a question aloud. But if this meeting or November is the last of the major “hawkish” super-sized hikes, I just wonder how much further downside “shocks” lay ahead.

ANOTHER RECORD: S&P 500 sell-off post August CPI is one of the 10 worst 5-day sell-offs post-CPI

The S&P 500 sell-off post-August CPI of -5%-ish is one of the 10 worst market reactions to CPI since 1970.

the 10 worst reactions are highlighted on the price chart below
notice something somewhat curious?
stocks seem to do pretty well going forward

This is difficult to tell if there is a causality issue. That is:

what if these CPI reports simply got reported at a time when S&P 500 was about to inflect higher?
this is possible, but what is curious is this is based upon 5-day market reaction
and it does seem like a strange coincidence that markets seem to bottom around bad CPI prints
after all, CPI is only reported every 30 days

The list of the 10 worst market reactions are below:

2 of the 10 are in 2022 (June 2022, post-May CPI)
2 of the 10 were back to back in 1974
and as we higlighted previously, that coincided with a local top in headline CPI

The 1974 CPI context is shown below. Those two reports coincided with an inflation peak by late-1974.

so it is important to keep the August CPI context in mind
a lot of bad news was priced in last week

INFLATION DATA: Plenty of data in the next 3 weeks

We have listed the key incoming inflation data points over the next two weeks (through 9/30) and as shown, there is plenty of data.

this week, FOMC
next week, Case-Shiller, Conference Board, regional PMIs
August PCE (Fed’s preferred) and U Mich. consumer inflation expectations

AUGUST CPI: Goods inflation surprisingly strong, including autos and apparel and home furnishings

While August CPI was certainly a negative surprise, the report was not entirely negative. I found the comments from GS Economists helpful:

core inflation is too high and as many economists noted
wage-sensitive and some sticky components seeing higher inflation
higher inflation seen even in goods
but the forward looking measures like PMIs, wage-trackers, etc show inflation cooling

FUTURE CPI: Futures market still sees Fed Funds peak April 2023, Inflation ~2.5% by June 2023

Even looking post-CPI, inflation futures still see inflation falling into 2023. While the “level” of inflation for each month crept up, the message is the same:

inflation peak is still looking like June 2022
Fed Funds peak still looking like April 2023
Inflation could fall to 2.5%-ish by June 2023
this is still encouraging, all things considered

SILVER LININGS: August CPI curiously showed apparel and home furnishing and autos accelerated in August

Lastly, while the overall message of the August CPI was a negative, it is not entirely all bad news:

47% of components are “deflating” from their 18 month peak, up from 42% in July
“goods” CPI was an upside surprise which was led by 3 categories
Autos, Apparel and Home furnishings
In fact, these 3 categories were a top 5 contributor in each of the regional CPIs

The fact that Goods CPI was +0.5% in August is a surprise. After all, goods are impacted by:

supply chains
commodity costs
fuel costs
PMIs show pricing easing

All of which have turned lower, so that fact the monthly increase rose:

July +0.2%
August +0.5%
surge in “goods” CPI

Auto CPI jumped significantly in August.. 14% of CPI and the largest sequential acceleration

As highlighted below, Auto CPI jumped significantly:

Auto goods +0.4% from +0.1% in July
Auto services +0.5% from -0.5% in July
these are among the largest sequential changes in inflation among major categories

The total weight of autos is 14% of CPI, so its a big deal. Below, the categories for goods and services is shown.

USER CAR CPI: Manhein down 11% YTD while CPI used cars flat

Look at the differential between used cars price index (Manheim) and the CPI used car index:

Manheim down 11% YTD
Used car CPI down 1.5%
as shown, Manheim leads CPI by 1-3 months
so a “bigger decline” in used cars should be in the pipeline
that is a silver lining

GOODS CPI: Why is household furnishing and apparel accelerating?

Another goods CPI curiousity is home goods and apparel:

household furnishing +1.1% vs +0.6% in July
that is a doubling of 12% annualized inflation. Why?
Apparel surged to +0.2% from -0.1% in July
with all these retailers cutting prices and with bloated inventory… why?

REGIONAL CPI: Surges driven by autos, apparel, household furnishing and housing

Curiously, the regional CPI show this same pattern.

the top 3 regions that saw a rise in sequential rates (monthly % change vs rate prior)
these are New England, Mid-Atlanic and West South Central

REGIONAL CPI: Look at top 4 accelerators…

In New England, look at top 4 contributors to the acceleration

Furnishings
Food at home
Shelter
Apparel

Whoa. Apparel and Furnishings?

In Mid-Atlantic, look at the top 4:

Fuel and utilities
Used cars/ autos
Apparel
Shelter
Why autos and apparel?

Look at West South Central:

Used cars/autos
Shelter
Apparel
Food away from home
why autos and apparel?

See the pattern? I am confused how apparel was a top contributor to CPI

STRATEGY: STRUCTURAL CAPITULATION: Since 1996, 13 prior instances of “0” Nasdaq advancers and only 6 when Nasdaq already down 25%

Since 1996, there have been 13 such prior instances where the Nasdaq 100 went completely “no bid”

these are plotted as dots below
the yellow are instances of zero advancers
the red are instances of zero advancers and when Nasdaq is already down 25% from an 18-month high

ZERO BID: 13 of 13 times, Nasdaq 100 higher median 12M gain 21%. When already >25% drawdown, median gain +64%

The forward returns for the Nasdaq post-zero bid are impressive:

13 instances, median 12M gain is 21%
100% win ratio, or 13 of 13 instances
when drawdown >25% in place, median 12M gain is +64%
staggering upside

This highlights that the Nasdaq has structurally bottomed. That is, when zero stocks advance, that is essentially one form of capitulation.

The scatter below highlights that the stronger the drawdown in place (x-axis), the greater the 12M upside.

the shaded red area are instances where Nasdaq drawdown was already >25%
the intercept of this regression implies Nasdaq 100 could have >40% upside in the next 12M

STRATEGY: 2H rally view intact

Given the list of market worries above, the natural question is how is there a positive thesis on equities into 2H2022? Here is our take:

our continuing analysis shows leading indicators point to disinflationary/deflation
US corporates remain impressively resilient, enduring the pandemic global shutdown with cost discipline
and US corporates are weathering the inflation surge impressively as well
the US economy has managed to absorb rapid Fed rate hikes so far
and US economic relative positioning far stronger in 2022
US net beneficiary of higher energy prices, absolute and relative (US exports oil)
US is on-shoring assets = future competitive advantage
US has labor issues, but this will be solved by either automation or rise in workforce participation
investor sentiment is rock bottom and worse than GFC by some metrics
fixed income markets show far less inflation in swaps, etc
and while many believe “bonds are getting it wrong” including Fed officials
the drop in energy and housing and other indicators are supportive of this lower inflation outlook
hence, Fed could do far less tightening as the market is doing Fed’s work

Bottom line. We see 2H rally thesis intact.

STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull

Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:

since 1942, there have been 14 such cycles
median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
since 1982, this ratio is only 15%

in 2022, the preceding bull market was 651 days
the current bear market was 164 (using 6/16)
or 25% ratio

As seen below, this ratio is solidly within the ranges seen since 1982.

many investors think “more time” is needed for this bear market
but given the shortness of the preceding bull market 651 days versus 1,309 median
the corresponding bear market should also be shorter

BUY THE DIP REGIME: Stocks already saw fundamental capitulation

And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.

this figure surged to 73% on 6/17
this was only exceeded 3 times in the past 30 years
each of the 3 prior instances was the market bottom
we think this is the 4th instance

BUY THE DIP: forward returns strong

And stocks have the best forward returns when this figure exceeds 54% as shown below:

in 3M, 6M and 12M
the best decile for returns
is when this figure is oversold >54%
hence, buy the dip regime is in force

33 GRANNY SHOTS: Updated list is below

The revised 33 Granny shots are shown below. The list is sorted by the most attractive (most frequently cited) to least. To be a “Granny shot” the stock needs to appear in at least two portfolios:

$AAPL in 5 of 6 portfolios
$GOOGL $MSFT in 4 of 6 portfolios
$AMZN $META in at least 2
This reinforces our favorable view of FANG in 2H2022

33 Granny Shot Ideas:

Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $TSLA

Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM

Communication Services: $GOOGL, $META

Energy: $CVX, $DVN, $XOM

Financials: $ALL, $AXP

Real Estate: $AMT, $CCI, $EXR

Health Care: $ABT, $BIIB, $ISRG, $MRNA, $REGN

Consumer Staples: $BF/B, $MNST, $PG, $PM

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33 Granny Shot Ideas: $AAPL, $GOOGL, $MSFT, $ALL, $BF/B, $CSCO, $NVDA, $PG, $PM, $ABT, $AMD, $AMT, $AMZN, $AVGO, $AXP, $AZO, $BIIB, $CCI, $CVX, $DVN, $EXR, $GPC, $GRMN, $ISRG, $KLAC, $META, $MNST, $MRNA, $PYPL, $QCOM, $REGN, $TSLA, $XOM

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INFLATION: Next 3 weeks will see lots of incoming data points around inflation trends…